It's Not the End of the World

Bernie Schaeffer, editor of the Option Advisor, says a recent bearish magazine cover story may be a good contrarian indicator that the market will move higher.

In March 1999—just a year before crude oil entered its greatest bull market in history—The Economist magazine informed us in a cover story that we were “Drowning in Oil” and that crude oil prices were headed for the single digits.

Here’s the “money quote”: “Since its peak in 1980, the price has fallen erratically. It has plunged by half in the past two years alone. In real terms, oil now costs roughly what it did before 1973. Crude is gushing from the ground at the rate of 66m barrels a day. The world is awash with the stuff, and it is likely to remain so.”

Yes, this view was horribly wrong in every respect, but what’s my point? Magazine cover stories are often the best representations of “consensus thinking,” and consensus thinking is, way more often than not, horribly wrong at major turning points in the markets. And [there’s] the strong possibility that in their January 11, 2010 cover story entitled, “Bubble Warning: Why Assets Are Overvalued,” our friends at The Economist may be repeating the debacle of their crude oil forecast just a shade over a decade ago.

According to this piece, “Stock markets are still shy of their record peaks in most countries. The American market is around 25% below the level it reached in 2007. But it is still nearly 50% overvalued on the best long-term measure, which adjusts profits to allow for the economic cycle, and is on a par with two of the four great valuation peaks in the 20th century, in 1901 and 1966…Today the prices of many assets are being held up by unsustainable fiscal and monetary stimulus. Something has to give.”

Does this gloomy view of the stock market represent consensus thinking? I believe so, as it is articulated over and over in the financial media. And proof of the pervasiveness of this skeptical viewpoint is the fact that individual investors are still withholding new money from US stock funds, despite a rally whose magnitude in past years would have created a flood of dollar inflows.

This consensus bearish view of the US stock market is counter-trend, which makes it all the more actionable from a contrarian standpoint.

That all said, the Standard & Poor’s 500 index has been stuttering and stumbling this month as it has approached its key 160-month moving average north of 1,150, and there is certainly the possibility of a tradable pullback if this is in fact a failure at this important level.

And even though the March 1999 Economist piece pretty much tagged the precise bottom in crude oil, a contrarian take on magazine covers requires patience, as the market often moves in the direction of the consensus over the short term. But on balance, investors should take comfort from all those pretty blue bubbles that recently graced that cover of The Economist.